So far, it hasn't been a very good year for real estate investment trusts (REITs).
However, this isn't to say these stocks have performed badly as a whole.
So far this year, the Dow Jones Equity REIT Total Return Index is up about 3.8%. Even though it's less than the return of the market -- the S&P 500 index is up more than 13% over the same period -- these aren't the numbers to really complain about. Especially in the context of this market environment. As we move a little more than six months into the year, the U.S. Federal Reserve has already hiked interest rates twice -- something that many had anticipated would trigger a REIT sell-off.
So, the good news is that the sector and its investors are taking the rate hikes in stride -- so far, at least.
But bad news is hiding in plain sight. The performance among REIT subsectors has been widely divergent, as the sector's investors sold off stocks impacted by some of the major economic shifts. I'm talking about the retail business, the big changes that this industry faces, and the subsequent reaction of the market.
According to REIT.com, the weakest two sectors this year are the retail sector and the self-storage sector.
It's easy to understand why retail REITs have lagged. U.S. consumer's habits have changed, with more and more shopping being done online, and malls are being shunned in the process.
Back in 1999, the share of e-commerce sales in the overall U.S. retail picture could have been mistaken as a mere rounding error... but now, it's a force to be reckoned with. In the first quarter of 2017, e-commerce sales represented 8.5% of all U.S. retail sales. And this mega-change continues to claim new victims, with revenues and profits for many major U.S. retailers falling, and more and more of them facing the threat of bankruptcy.
According to REIT.com data, shopping mall operators lagged even the retail REIT sector. On the other hand, the so-called "free-standing REITs" did better than the rest of the retail group.
It's a distinction that's important my Daily Paycheck subscribers and I because our only retail REIT is one such company. It owns and operates freestanding buildings, i.e., retail locations not anchored to malls. This means it's a better-positioned stock, not only because of operational experience and business knowledge, but also because it's simply a better business in this environment, with its exposure more to consumer staples (grocery stores, drug stores, and other businesses that sell goods and services at low price points).
As a result, my Daily Paycheck subscribers and I are earning a 4.5% yield and sitting on a 36.2% gain at last count.
The story is slightly different with self-storage REITs -- REITs that own and manage storage facilities and collect rent from tenants, one of which is represented in our portfolio as well.
This sector largely benefitted from a supply-demand imbalance (lack of new supply while demand was growing), increasing business awareness and technological advances that improved efficiency. As a result, its growth was on par with certain growth stocks.
In other words, self-storage was a young, emerging sub-industry with relevant growth rates.
Now, as the industry matures, its growth has slowed and investors have become concerned that the best days of the self-storage industry are behind it.
That may be part of the reason why we're sitting on a slight loss after adding our storage REIT to the Daily Paycheck portfolio in January.
But I don't believe this space's best days are behind it. The self-storage business, unlike malls, has strong fundamentals and isn't endangered by the advent of e-commerce. I suspect that, as the market starts to price in this slowing growth, many investors will understand that the self-storage business still offers better growth than much of the REIT sector, and, as a result, better prospects for dividend increases. In the meantime, we'll collect our 4.5% yield and wait.
And data centers stood out, too, but in a good way: the sector is up more than 20% in the first six months of the year.
Our portfolio's holding in this space illustrates why. Unlike many other REIT sectors, data center REITs are leveraged to some of the better-growth areas available in the REIT business. That's one of the reasons why we're sitting on a 49.8% gain after adding it to our portfolio in February 2016.
Our holding (which I can't reveal here) is on especially good footing after a recent acquisition. It currently yields just a shade above 3% (I expect more dividend hikes in the future), and it's now the dominant force in the data industry -- a good position to be in going forward.
And, indeed, the performance of mortgage REITs in 2017 deserves to be highlighted. Up double-digits as a group, these stocks all but shrugged off the prospect of higher rates. But I still think this is the most vulnerable group in that respect, hence the more cautious stance I've recently taken regarding the sector.
All of this to say REITs still deserve their place in income portfolios. Not only do these stocks generate decent income (especially by today's standards), but that income is poised to grow for the best of the group as rents rise and profits increase.
In addition, the group offers significant diversification benefits, with the long-term average correlation between exchange-traded equity REITs and non-REIT stocks being quite low, according to reit.com, an industry group. Over the 26-year period from 1990 to 2016, the correlation in monthly total returns between equity REITs and the broad stock market was only 58%.
Of course, these correlations can change as the market and the economy progress. But REITs offer something that's hard to obtain otherwise -- investment exposure to the various sides of real estate with minimal capital requirements and with much higher liquidity than physical real estate offers. In short, this is a sector not to be ignored.
P.S. These lucrative REITs make up only a small part of my wildly successful Daily Paycheck retirement system. This simple, three-step process allows my subscribers to pull in thousands of extra dollars each month.
Click here for the names of my favorite REITs (and to see the rest of my portfolio) -- you'll also see how easy it is for you to start collecting paychecks each and every day.
This article originally appeared on Street Authority.